Comparisons between the Markowitz Model and the Black–Litterman Model

Huei-Wen Teng

Chapter 85 in Handbook of Investment Analysis, Portfolio Management, and Financial Derivatives:In 4 Volumes, 2024, pp 2727-2749 from World Scientific Publishing Co. Pte. Ltd.

Abstract: Model risk is critical in constructing a portfolio. To avoid model risk, the Black–Litterman model is an approach that allows to adjust the original estimated parameters using the implied market equilibrium returns and investors’ views (Black and Litterman, 1991). This chapter contrasts the standard approach of Markowitz (1952) with the Black–Litterman model and reviews different investment philosophies by Longo (2021). For empirical demonstrations, we consider a predictive regression to form investors’ views, where asset returns are regressed against their lagged values and the market return. Motivated by stylized features of historical returns, we employ heteroscedastic time-series models. Empirical analysis using five industry indexes in the Taiwan stock market shows that the proposed Black–Litterman portfolio outperforms the 1/N portfolio and Markowitz portfolio.

Keywords: Financial Accounting; Financial Auditing; Mutual Funds; Hedge Funds; Asset Pricing; Options; Portfolio Analysis; Risk Management; Investment Analysis; Momentum Analysis; Behavior Analysis; Futures; Index Futures; CDCs; Financial Econometrics; Statistics; Financial Derivatives; Financial Accounting (search for similar items in EconPapers)
JEL-codes: G1 G11 G12 G3 M41 M42 (search for similar items in EconPapers)
Date: 2024
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